Tuesday, January 01, 2008

Yet another swing against insider trading

In a move to curb insider trading, the Securities and Exchange Board of India (Sebi) today proposed that an `insider’ in a company should surrender profits made in any equity-based securities transactions of the company, if both the buy and sell side of the transaction are entered into within six months of the other.

This is the latest in a series of doomed legislations as I would call it. Insider trading regulations have failed to be effective because they seek to achieve the theoretical “level playing field” or “information democracy”. Is it not just human nature to take advantage of knowledge? Does it not happen in other walks of life? Imagine Californian gold rush. Did the first prospectors scream from top of the roof that they’ve struck gold? Should ONGC and Reliance alert other explorers to oil finds? Should we ban scientists from filing patents of their inventions? All these could be construed as insider information, in a way. We all take advantage of the information that we come to possess (with absolutely no sense of guilt) and why shouldn't we?

I feel so long as there are insiders, they will take advantage of knowledge they have access to. That is enterprise. In a way, by default, it automatically places all confidential, price sensitive information in public domain because when insiders buy, it reflects in a sudden spike in share price and volume of trading in that stock. If others are watchful enough, that acts as the best gauge of something brewing. Advanced corporations are now using internal betting markets to tell them what the official chain of command will not. They are inviting their employees to anonymously bet on when projects will really be completed. The results are more accurate.

Legislation have never been known to prevent white collar crimes, it has only stimulated creativity in criminals. Trying to ban it by legislation does not automatically mean plugging that hole and creating a level playing field. It would just tempt the shrewd insiders to devise ways to take a proxy route to exploit the opportunity.

Why don’t we look at it as one of those equity-efficiency tradeoffs? Sure, if we allowed insider trading, then prices would better reflect the firm's true value. But it would be a wealth transfer from price-sensitive traders to corporate insiders. What say you?

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